UPDATE 1-US SEC short-selling curb seen likely extended

(Adds groups urging SEC against extending short sale rule, paragraphs 9-10)

By Rachelle Younglai

WASHINGTON, July 21 (Reuters) - An emergency rule to curb abusive short selling will likely be extended beyond 19 major financial firms as pressure mounts on the U.S. Securities and Exchange Commission to broaden the measure.

The impact of the SEC's rule is being closely monitored as brokers and dealers are now required to borrow stock before executing a short sale in 17 major Wall Street firms and mortgage finance giants Freddie Mac (FRE.N) and Fannie Mae (FNM.N).

The rule, which went into effect on Monday and can last up to 30 days, also requires investors to deliver securities on the settlement date.

The SEC announced its rule July 15, after bank regulators seized IndyMac July 11 and the Federal Reserve and Treasury Department announced emergency support on July 13 to ensure Freddie and Fannie would have access to capital if needed.

Although short selling is a legitimate investment strategy and can prevent stocks from becoming overvalued, lawmakers and corporate executives have called for a probe of short sellers since the demise in March of investment bank Bear Stearns.

The SEC has already said it will consider rules to address abusive short selling issues across the entire stock market. But it is unknown how the agency will craft that rule.

"We cannot have a segregated market where only the large and connected get protected by the SEC," said former SEC commissioner Roel Campos, now a partner at law firm Cooley Godward Kronish.

The American Bankers Association is lobbying the SEC to include all publicly traded banks and bank holding companies such as Washington Mutual Inc WM.N and Wachovia Corp WB.N, which have been under pressure.

But the Coalition of Private Investment Companies and the Managed Funds Association said they sent a letter to SEC Chairman Christopher Cox on Monday urging against extending the order in either duration or the securities currently covered.

"Such action would severely burden short selling activity, which the SEC itself repeatedly has acknowledged plays a vital role in the stability of securities markets," said James Chanos, a well known short seller, who chairs the coalition.

The SEC's order only covers the primary dealers that have access to the Federal Reserve's discount window and many of those firms are foreign-based such as Swiss-based UBS AG (UBSN.VX) and London-based HSBC Holdings (HSBA.L).

"I don't think you could limit it to those 19 names pushed on the SEC by the Federal Reserve, to protect all dealers in government securities," said John Coffee, professor at Columbia Law School.

Under pressure from the exchanges and the Securities Industry and Financial Markets Association, the SEC on Friday granted a partial exemption for market makers, or those who facilitate trading in certain stocks.

Market makers don't have to pre-borrow stock before executing a short sale in the 19 financial companies but must deliver the stocks within the settlement period.